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101’s - Understanding Different Types of Property

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Shopping Centers 101

They’re the big malls out in the suburbs, the local supermarkets, the downtown plazas and strip malls along the highway. They are the bustling centers of retail and icons of modern American life. They are shopping centers, and though the eyes of an educated investor, they are also solid investments with high rates of return. These commercial properties are exciting ventures requiring you to consider infrastructure, traffic counts and the needs of the surrounding communities.

Know Your Spaces

By dictionary definition, a shopping center is nothing more than a sheltered area designated as retail space, but this doesn’t accurately describe the industry’s diverse nature. According to the International Council of Shopping Centers (ICSC), a shopping center is a group of retail and other commercial establishments that is planned, developed, owned and managed as a single property, with on-site parking provided. From there, shopping centers are broken into two categories—malls and open-air centers—with several subsets.

Malls
Regional Centers: These are your typical shopping malls. This center provides general merchandise (a large percentage of which is clothing) and a varity of other service businesses. Its main attraction is the combination of anchors, which may be traditional, mass merchant, discount or fashion department stores, with numerous fashion-oriented specialty stores. Regional centers have parking along their perimeters and stores are connected by a common walkway.

These properties typically utilize 40 to 100 acres of land. Their anchor tenants often lease 50 to 70 percent of the mall’s space and its primary trade area reaches out five to fifteen miles.

Super Regional Center: These are basically super-sized malls. Everything is the same, except there’s more of it. There are more anchor tenants, more variety in stores. Super malls pull a larger population base and the parking is structured to accommodate the sheer size of the mall.

These properties typically utilize 60 to 120 acres of land. Their anchor tenants often lease 50 to 70 percent of the mall’s space and its primary trade area reaches out five to twenty-five miles.

Open-air Centers
According to the ICSC, an attached row of stores or service outlets managed as a unit, with on-site parking usually located in front of the stores and common areas that are not enclosed is known as an open-air center. Open canopies may connect the storefronts, but an open-air center does not have enclosed walkways linking the stores. Open-air centers come in six different shapes and sizes: neighborhood centers, community centers, power centers, theme/festival centers, outlet centers and lifestyle centers.

Neighborhood Centers: These shopping centers are designed to service the needs of consumers in the immediate neighborhood. Supermarkets anchor almost half of these centers, while nearly a third are home to major drug stores.

These properties typically utilize three to fifteen acres of land. Anchor tenants often account for 30 to 50 percent of leased space and the center’s primary trade area reaches out three miles.

Community Centers: These are similar to neighborhood centers, except bigger. Supermarkets and super drug stores often anchor community centers, but this is where you’ll also see the big box stores like Wal-Mart and Best Buy.
These properties typically utilize 10 to 40 acres of land. Anchor tenants often account for 40 to 60 percent of leased space and the center’s primary trade area reaches out three to six miles.

Lifestyle Centers: These shopping centers are often found near affluent residential neighborhoods. These spaces cater to the lifestyle pursuits of the surrounding neighborhood and typically include upscale restaurants and amenities such as fountains. This is where you’ll often find Starbucks, bookstores and other accompanying retailers.

These properties typically utilize 10 to 40 acres of land. Anchor tenants often account for up to 50 percent of leased space and the center’s primary trade area stretches out eight to twelve miles.

Power Centers: These are shopping centers dominated by several large anchor tenants, including discount department stores, warehouse clubs, or “category killers,” which offer a variety of related merchandise categories at very competitive prices (think Lowe’s or Home Depot). Some of the anchor tenants may be in freestanding, unconnected facilities.

These properties typically utilize 25 to 80 acres of land. Anchor tenants often account for 75 to 90 percent of leased space and the center’s primary trade area stretches out five to ten miles.

Outlet Centers: This type of property consists of manufacturers’ and retailers’ outlet stores selling brand-name goods at a discount. These centers typically lack an anchor tenant, however, certain brand-name stores may serve as magnet tenants. The primary trade area for these centers stretch 25 to 75 miles and they typically utilize 10 to 50 acres of land.

Theme/Festival Center: These centers are typically carried by a unifying theme that ties the shops together, and to an extent, the merchandise as well. Entertainment is usually the main attraction, although it may come in the form of a shopping experience as much as in the tenants. These centers typically target tourists and often utilize five to twenty acres of land.

Cash Flow

Receiving a check from your tenants every month in a residential property can be quite a bit different than generating cash flow from your retail property. Retail businesses rely on consumers to provide income for that business, which in turn uses some of that capital to pay you, the landlord. The most important thing to remember when investing in a shopping center is that income is rarely constant for the business from one month to the next. A Christmas store that opens in July probably won’t generate many sales until much later in the year. Likewise a golf shop probably doesn’t do much business in January and February in northern states.

While established businesses are less likely to default on the monthly rent check, shifts in the retail market happen often and hundred-year-old retailers can go out of business just like a start-up. Be wary when looking into a retailer’s financial position. Look into the retailer’s profit margins for a number of previous years and try to identify any cycles where sales may be slow. You don’t want to be in a situation where the retailer can’t pay rent because it doesn’t have enough cash to get through a slow quarter, or worse, goes bankrupt.

As in any commercial real estate investment, you’ll also want to pay particular attention to a shopping center’s cap rate. A capitalization rate, or “cap rate,” is a ratio of net income and capital cost. It is calculated by taking the net operating income (NOI) for the building and dividing by the purchase price. For example, a building purchased for $1 million that generates $100,000 in net operating income has a cap rate of 10 percent.

$100,000 / $1 million = 10% cap rate

When valuing properties it is useful to think of the cap rate the same way you would look at a rate of return for any other investment. The higher the cap rate, the higher the rate of return on the investment, but also the higher the perceived risk. Cap rates vary depending on the location, size and history of the property. Once a cap rate is determined, it is divided by the NOI to determine the value of the property. For example, a shopping center at a 7 percent cap rate with $140,000 NOI will be valued at $2 million dollars.

$140,000 / 7% = $2 million

For Your Consideration

Besides cap rates and cash flow, you’ll want to look at another aspect of a potential shopping center purchase before signing on the dotted line—location. The location and accessibility of your shopping center is what will make or break your investment in the long run.

In order for a business to keep its doors open, it needs traffic. Unfortunately prime traffic spots push up the price of the property because of its good location, which is why retail space is typically more expensive than ordinary office space. But the premium will be worth the cost of a successful project.

If the property is located downtown, foot traffic may be enough to allow your tenants to make healthy profits, but you’ll want to know how many people pass through the area on any given day. If you project is on a major arterial roadway, then you will need to find out how many cars travel down past the site each day. Fortunately, the local downtown authority or county road commissioner may have all the research you need. Local government entities should have current and historic traffic surveys of your area of interest. By studying this data, you can see if traffic in the area is growing, slowing or riding a plateau.

Financing

Receiving financing for a retail real estate purchase is much the same as any commercial investment. Your lender will look at aspects such as risk, potential return on investment and cash flow, as well as your personal credit history and other criteria. As you may know, instead of paying the balance of the loan with your personal income, you use money generated from the cash flow of the retail property to make payments. Many banks will have a set income-to-debt ratio, called debt service coverage ratio (DSCR) that you will be required to maintain during the life of the loan. A DSCR of 1.0 means for every dollar of net income there is a dollar of debt repayment. Expect most lending institutions to require a DSCR of at least 1.25 — one dollar and twenty-five cents net income for each dollar of debt repayment — before they consider a loan viable.

Leases

The leasing options available for shopping malls are the same as any lease in commercial real estate: the gross lease, modified gross lease and triple-net lease. Gross leases usually benefit the lessee the most. The renter only has to pay rent, while the owner of the property is responsible for paying all other expenses such as utilities, repairs, insurance and taxes. A triple-net lease is the opposite of the gross lease, where all burdens of taxes, utilities, maintenance and rent are the responsibility of the tenant. A modified gross lease is between the two – the tenant and the property owner share some of the costs (such as the tenant paying rent, utilities and taxes while the owner is responsible for building maintenance and upkeep).

More often than not shopping center leases are triple-net. The expenses, like utilities and taxes will often be capped with administrative fees capped at a certain percentage. The lease are anywhere from three years to thirty, often with renewable options. Anchor tenant spaces are typically much less expensive on a square foot basis than small shop space, as the anchors draw the customers into the mall that then shop at the smaller stores.

Retail leases can be different from other commercial real estate in another way, as base rents can be combined with percentage of gross sales. For example, a store may have a base rent of $1,000 per month with additional 5 percent on gross sales. These may be tiered with the store paying a percentage of all gross sales over a certain amount, for example 5% on all sales over $240,000.

($1,000 * 12) + 5 percent of sales > $240,000

In the example above, total rent is equal to base rent plus percentage rent. Assuming the store produces $300,000 in gross sales in a month, the total rent is:

$1,000+0.05($300,000-$240,000) = $4,000

Management

Unlike many other facets of commercial real estate, retail investors will typically manage their properties in-house, meaning they will hire staff to take care of maintenance and bookkeeping, avoiding a property management company. The reasoning behind this lies in the fact that with shopping malls you typically don’t have to deal with tenants locking themselves out in the middle of the night, and tenants are usually responsible for their own spaces, so you don’t have to fix the broken toilets. You will need maintenance people for taking care of the common areas as well as bookkeepers, so you’ll want ensure that you included their salaries in your overall budget for the property.

Conclusion

Malls and other large shopping centers may not have been in your crosshairs as a potential investment. They’re big, they’re expensive and usually require a long-term commitment – much longer than your typical single- or multi-family residential project. Being the landlord of a even a small mall involves dealing not with the single mother and elderly couple, but with very large corporations as tenants and their layers of management. Financing may also easily be the largest monetary commitment you’ve made as an investor, as the purchase price for shopping centers can reach into the tens of millions of dollars. But if you plan properly, your best purchase at the mall may be the mall itself.